[Federal Register Volume 84, Number 27 (Friday, February 8, 2019)]
[Notices]
[Pages 2938-2941]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-01553]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85047; File No. SR-ICC-2019-001]
Self-Regulatory Organizations; ICE Clear Credit LLC; Proposed
Rule Change Relating to the ICE CDS Clearing: Back-Testing Framework
February 4, 2019.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934,\1\ and Rule 19b-4,\2\ notice is hereby given that on January 28,
2019, ICE Clear Credit LLC (``ICC'') filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change as
described in Items I, II and III below, which Items have been prepared
by ICC. The Commission is publishing this notice to solicit comments on
the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1)
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
The principal purpose of the proposed rule change is to revise the
ICE CDS Clearing: Back-Testing Framework (``Back-Testing Framework'').
These revisions do not require any changes to the ICC Clearing Rules
(``Rules'').
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, ICC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. ICC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
(a) Purpose
ICC proposes to update and formalize the Back-Testing Framework
that describes ICC's back-testing approach, back-testing procedures,
and guidelines for remediating poor back-testing results. ICC proposes
to formalize the Back-Testing Framework following Commission approval
of the proposed rule change.
ICC's Back-Testing Framework includes a discussion of ICC's back-
testing approach to verify that the number of actual losses is
consistent with the number of projected losses. Generally, ICC's back-
testing analysis counts the number of occurrences, also referred to as
exceedances, when the observed portfolio loss for a given horizon is
greater than the model projected risk measure, defined as the sum of
the selected initial margin components. The total number of exceedances
is evaluated against the desired risk quantile and the model is
considered well calibrated if the number of exceedances is consistent
with the chosen risk quantile. The Back-Testing Framework also
addresses multi-currency portfolios by accounting for the foreign
exchange risk exposure and summarizes the associated back-testing
analysis, which is performed in the clearinghouse base currency (i.e.,
U.S. Dollar).
ICC utilizes the Basel Traffic Light System (``BTLS'') to assess
the soundness of its risk management model (``model''). The Back-
Testing Framework contains a summary of the BTLS, including
descriptions and calculations associated with each zone of the BTLS.
The BTLS is based on three zones: Green, yellow, and red. Each zone is
defined by the maximum number of acceptable exceedances. In practice,
the more portfolios that fall within the green zone, the sounder the
model. The BTLS does not penalize the model for conservativeness.
The Back-Testing Framework contains ICC's procedures for performing
back-testing analyses. The ICC Risk Management Department (``ICC
Risk'') performs daily, weekly, monthly, and quarterly portfolio-level
back-testing analyses. The Back-Testing Framework sets forth ICC's
calculation of the observed loss, which is referred to as the N-day
worst unrealized profit/loss (``P/L''), using the changes in portfolio
net asset values (``NAVs''). The initial margin risk horizon is
reflected as ``N-day'' where N>=5 is the initial margin risk horizon or
the Margin Period of Risk (``MPOR''). The back-testing analysis is
based on the greatest MPOR, rounded up to the nearest integer, for
instruments in the considered portfolio. For example, if an instrument
is subject to 5.5-day MPOR estimations, then the back-testing analysis
is performed by comparing the model projected risk measure to the N-day
worst unrealized P/L with N=6. The model projected risk measure, which
is subject to back-testing, is the sum of the following selected
initial margin components: Integrated spread response, basis risk, and
interest rate sensitivity (``back-tested components''). Under the Back-
[[Page 2939]]
Testing Framework, the remaining components of initial margin are
excluded because they are not always market observed and statistically
modeled.
ICC back-tests its model with Clearing Participant (``CP'')
portfolios and a hypothetical set of portfolios (``special strategy
portfolios'') at the 99.5% risk quantile. Under the Back-Testing
Framework, back-testing analysis is performed for the model at the
99.5% risk quantile for all CP-related portfolios. The Back-Testing
Framework also includes a sample set of special strategy portfolios,
which allow ICC to consider a range of hypothetical but realistic
portfolios in its back-testing analysis. Back-testing results for the
special strategy portfolios are reviewed periodically to identify and
assess potential weaknesses in model assumptions.
The Back-Testing Framework describes ICC's procedures for reporting
back-testing results. Daily portfolio back-testing results are reported
on a periodic basis for each CP based on the appropriate MPOR. The
Back-Testing Framework provides example computations for a sample MPOR
of 5 days (i.e., all instruments in the considered portfolio are
subject to a 5-day MPOR). For each day in the back-testing period, all
components of initial margin are provided, and the back-tested
components and non-back-tested components are identified. The sum of
the back-tested components is given alongside the unrealized P/L and
the associated shortfall. An exceedance summary shows the total number
of exceedances in the period and states the maximum number of
exceedances that satisfy each zone in the BTLS. Back-testing results
for the full period are also reported, and the back-tested components
and the N-day P/L results for every back-tested day are computed for
each portfolio associated with a given CP.
The Back-Testing Framework discusses the exceedance summaries that
are provided when ICC back-tests its model with CP and special strategy
portfolios at the 99.5% risk quantile. The Back-Testing Framework notes
the reporting frequency, along with the information that is delivered
as part of an exceedance summary, such as the number of observations
and exceedances for the set of back-testing results and the maximum
number of exceedances allowed in each zone in the BTLS. Moreover, in
addition to assessing the model's performance by back-testing, the
Back-Testing Framework directs ICC Risk to conduct monthly parameter
reviews and parameter sensitivity analyses.
ICC Risk also periodically reports univariate back-testing results,
namely, instrument and Risk Factor \3\ (``RF'') back-testing results,
depending on market conditions. The Back-Testing Framework discusses
how back-testing results are computed and reported for SN RFs and index
instruments. As noted above, the back-testing analysis is performed for
the model at the 99.5% risk quantile and exceedance summary results are
generated. The Back-Testing Framework defines the model projected risk
measure with respect to univariate back-testing as the sum of the
integrated spread response and the interest rate sensitivity
(``univariate back-tested components'') and directs ICC Risk to perform
several analyses if an exceedance is observed, which include, among
others, an analysis of the spread and recovery rate changes. The Back-
Testing Framework also contains information regarding ICC Risk's
performance of univariate back-testing analysis in spread log-return
space, including the utilization of different mean absolute deviation
estimates and an indication of when such analysis may be performed.
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\3\ ICC deems each index, sub-index, or underlying single name
(``SN'') reference entity a separate RF.
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The Back-Testing Framework provides guidelines for remediating poor
back-testing results. Back-testing results are identified as poor if
the number of observed exceedances at the portfolio level falls in the
red zone of the BTLS. The Back-Testing Framework discusses various
actions to be taken upon the identification of poor back-testing
results, which include seeking feedback from the Risk Working Group
(``RWG'') \4\ and consulting with the Risk Committee on any necessary
remedial action. The Back-Testing Framework describes an instance where
the number of exceedances falls in the red zone but may not be
indicative of poor back-testing results, namely, where overlapping
back-testing periods are involved and the effects of one adverse
observation are responsible for a cluster of exceedances. The Back-
Testing Framework provides the Chief Risk Officer and Risk Oversight
Officer with the responsibility and the authority to determine whether
the number of exceedances is indicative of poor back-testing results.
The Back-Testing Framework also notes the actions to be taken if the
number of exceedances falls in the yellow zone, including a review by
ICC Risk to determine the cause of the model's worsened performance
and, if necessary, a complimentary back-testing analysis without
overlapping back-testing periods.
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\4\ The RWG consists of risk personnel from CPs and provides
input to help ensure ICC's risk management framework is robust.
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Under the Back-Testing Framework, if poor back-testing results are
identified at the portfolio level, individual RF back-testing results
are further analyzed. The Back-Testing Framework contains information
regarding the analysis if poor back-testing results are identified for
certain RFs, including analysis on the spread log-return statistical
model assumptions, estimation techniques, and estimated parameters.
To remediate poor back-testing results, the Back-Testing Framework
provides ICC Risk with the authority to take various actions depending
on the situation, including updating statistical parameters (i.e.,
parameters estimated by statistical analysis of data sets) and
increasing the frequency of parameter updates. The Back-Testing
Framework references several situations that may lead to poor back-
testing results, along with the actions that ICC Risk may take for
remediation, including poor back-testing results associated with
distressed SN RFs, poor performance at the portfolio level driven by
improper portfolio benefits, and poor back-testing results due to
recent changes in the dependence structure among RFs. Under the Back-
Testing Framework, ICC Risk may apply additional initial margin while
investigating the model's poor performance and, if needed, recommend
model enhancements to the Risk Committee and the Board.
(b) Statutory Basis
Section 17A(b)(3)(F) of the Act \5\ requires, among other things,
that the rules of a clearing agency be designed to promote the prompt
and accurate clearance and settlement of securities transactions, and
to the extent applicable, derivative agreements, contracts and
transactions; to assure the safeguarding of securities and funds which
are in the custody or control of the clearing agency or for which it is
responsible; in general, to protect investors and the public interest;
and to comply with the provisions of the Act and the rules and
regulations thereunder. ICC believes that the proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to ICC, in particular, to Section
17(A)(b)(3)(F),\6\ because ICC believes that the proposed rule change
to formalize the Back-Testing
[[Page 2940]]
Framework promotes the soundness of ICC's risk management model. The
Back-Testing Framework describes ICC's back-testing approach, back-
testing procedures, and guidelines for remediating poor back-testing
results. The various elements set forth in the Back-Testing Framework
assess the ability of the model to reliably forecast risk at the
selected risk quantile and ensure that ICC takes appropriate remedial
action upon the identification of poor back-testing results. The Back-
Testing Framework provides assurances as to the appropriateness of the
model, including the appropriateness of margin requirements, thereby
facilitating ICC's ability to promptly and accurately clear and settle
its cleared CDS contracts; enhancing ICC's ability to assure the
safeguarding of securities and funds which are in the custody or
control of ICC or for which it is responsible; and protecting investors
and the public interest. Moreover, ICC believes that having policies
and procedures that clearly and accurately document ICC's back-testing
procedures are an important component to the effectiveness of ICC's
risk management system, which promotes the prompt and accurate
clearance and settlement of securities transactions, derivatives
agreements, contracts, and transactions; the safeguarding of securities
and funds which are in the custody or control of ICC or for which it is
responsible; and the protection of investors and the public interest.
As such, the proposed rule change is designed to promote the prompt and
accurate clearance and settlement of securities transactions,
derivatives agreements, contracts, and transactions; to contribute to
the safeguarding of securities and funds associated with security-based
swap transactions in ICC's custody or control, or for which ICC is
responsible; and, in general, to protect investors and the public
interest within the meaning of Section 17A(b)(3)(F) of the Act.\7\
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\5\ 15 U.S.C. 78q-1(b)(3)(F).
\6\ Id.
\7\ Id.
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In addition, the proposed rule change is consistent with the
relevant requirements of Rule 17Ad-22.\8\ Rule 17Ad-22(b)(2) \9\
requires ICC to establish, implement, maintain and enforce written
policies and procedures reasonably designed to use margin requirements
to limit its credit exposures to participants under normal market
conditions and use risk-based models and parameters to set margin
requirements and review such margin requirements and the related risk-
based models and parameters at least monthly. The Back-Testing
Framework requires the remediation of poor-back-testing results; the
performance of daily, weekly, monthly, and quarterly portfolio-level
back-testing analyses; and the performance of monthly parameter reviews
and parameter sensitivity analyses. Such procedures serve to promote
the soundness of ICC's risk management model and to ensure that ICC's
risk management system is effective and appropriate in addressing the
risks associated with clearing security based swap-related portfolios.
Namely, by requiring that ICC review and improve the model, the Back-
Testing Framework promotes ICC's use of margin requirements to limit
its credit exposures to participants under normal market conditions and
ICC's use of risk-based models and parameters to set margin
requirements and review such margin requirements and the related risk-
based models and parameters at least monthly, consistent with Rule
17Ad-22(b)(2).\10\
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\8\ 17 CFR 240.17Ad-22.
\9\ 17 CFR 240.17Ad-22(b)(2).
\10\ Id.
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Rule 17Ad-22(b)(3)\11\ requires ICC to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain sufficient financial resources to withstand, at a
minimum, a default by the two CP families to which it has the largest
exposures in extreme but plausible market conditions. The Back-Testing
Framework supports ICC's ability to maintain sufficient margin
requirements and enhances ICC's approach to identifying potential
weaknesses in the risk methodology by measuring the quality of its
model using the BTLS, thereby ensuring that ICC continues to maintain
sufficient financial resources to withstand, at a minimum, a default by
the two CP families to which it has the largest exposures in extreme
but plausible market conditions, consistent with the requirements of
Rule 17Ad-22(b)(3).\12\
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\11\ 17 CFR 240.17Ad-22(b)(3).
\12\ Id.
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Rule 17Ad-22(d)(8) \13\ requires ICC to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to have governance arrangements that are clear and transparent
to fulfill the public interest requirements in Section 17A of the
Act.\14\ The Back-Testing Framework clearly assigns and documents
responsibility and accountability for performing back-testing analyses
and remediating poor back-testing results. These governance
arrangements are clear and transparent, such that information relating
to the assignment of responsibilities and the requisite involvement of
the Chief Risk Officer, the Risk Oversight Officer, ICC Risk, the RWG,
the Risk Committee, and the Board is clearly documented, consistent
with the requirements of Rule 17Ad-22(d)(8).\15\
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\13\ 17 CFR 240.17Ad-22(d)(8).
\14\ 15 U.S.C. 78q-1.
\15\ 17 CFR 240.17Ad-22(d)(8).
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(B) Clearing Agency's Statement on Burden on Competition
ICC does not believe the proposed rule change would have any
impact, or impose any burden, on competition. The proposed change to
formalize the Back-Testing Framework will apply uniformly across all
market participants. Therefore, ICC does not believe the proposed rule
change imposes any burden on competition that is inappropriate in
furtherance of the purposes of the Act.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments relating to the proposed rule change have not been
solicited or received. ICC will notify the Commission of any written
comments received by ICC.
III. Date of Effectiveness of the Proposed Rule Change
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-ICC-2019-001 on the subject line.
[[Page 2941]]
Paper Comments
Send paper comments in triplicate to Secretary, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-ICC-2019-001. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filings will also be available for inspection
and copying at the principal office of ICE Clear Credit and on ICE
Clear Credit's website at https://www.theice.com/clear-credit/regulation.
All comments received will be posted without change. Persons
submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-ICC-2019-001 and should be
submitted on or before March 1, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-01553 Filed 2-7-19; 8:45 am]
BILLING CODE 8011-01-P